-->How To Relax And Enjoy The End Of The World

The Daily Reckoning

Paris, France

Wednesday, 15 January 2003

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*** Paul Volcker worries about the dollar...

*** What were bond buyers smoking?

*** How the mutual fund industry helped separate fools from
their money - and more!

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Not for the first time in his life, Paul Volcker is worried
about the value of the dollar. It was Volcker, not Alan
Greenspan, who was at the helm of the Fed when inflation
rates hit double digits in the late '70s. It was he who
brought inflation under control...and set in motion the
Great Boom which lasted for the next 20 years.

The entire financial system was in jeopardy; faith in the
dollar had to be restored. Volcker did it by forcing
interest rates up to 18% and squeezing the money supply
until there was little inflation left in it...which left
his successor at the Fed free to allow rates to come down
for the next two decades.

It wasn't easy. Crowds gathered and burnt an effigy of
Volcker; they might have burnt the man himself if they'd
been able to get ahold of him.

For the moment, by contrast, Mr. Greenspan is safe.

"We've had a very strong dollar," Volcker said, noting that
it came with a remarkably high current account deficit.
"That'll be adjusted someday," he said."And we have a nice
question whether it will be adjusted in an orderly way or
in a disorderly way, and we've left ourselves a little
vulnerable.

"And someday we are going to have to get into an economic
situation where we are saving a little more, spending less
relative to the GNP, and paying a little bit more of our
way internationally," Volcker added."And we're not making
very much progress in any of those directions in the short
run..."

Every time a person adds to his mortgage, he becomes more
vulnerable. Likewise if he buys stocks at today's high
prices. If panic selling of the dollar begins, he's in
trouble - stocks will go down and mortgage rates will go
up.

To make matters worse, American manufacturers are getting
pressure on both sides of the ledger - from China. Their
costs are going up; China is buying so many raw materials
that prices are rising. And their revenues suffer - because
China's finished products are so cheap. How are they going
to compete? They'll find a way...but probably at a lower
dollar price.

It will all be adjusted someday...including the favor Mr.
Greenspan currently finds in the eyes of the American
lumpeninvestoriat....

...but not without wailing and gnashing of teeth.

Eric, what happened yesterday?

-----------

Eric Fry, reporting from Wall Street...

- Another lazy day on Wall Street yesterday. The Dow Jones
Industrial Average shuffled along 56 points to 8,842, and
the Nasdaq ambled 15 points higher to 1,461. Meanwhile,
gold drifted lower, falling $2.70 to $352.40 an ounce.

- The dollar drifted lower as well. Despite the friendly
influences of a strengthening stock market and a softening
gold price, the dollar's pathetic sell-off continued. The
greenback fell half a percent against the euro at $1.0590 -
- its lowest level in more than three years.

-"Is dollar party is finally over?" The Economist magazine
wonders. We here at the Daily Reckoning have been wondering
the same thing for some time. We are not wondering
anymore...When the punch bowl is empty and the ice statues
have become mere puddles, the polite guest retrieves his
overcoat and bids the host"Goodnight." The party is over.

-"For years, currency experts have been confidently - and
largely mistakenly - forecasting the decline of the
dollar," the Economist reminisces."They were able to
marshal an impressive array of evidence in support of their
arguments...America could not continue to absorb the large
capital inflows which had propped up the greenback for so
long. The euro, after its creation in January 1999, would
soon challenge the dollar's reserve-currency status...Yet
the dollar...remained impervious to economic forecasts. The
world's most important currency continued to be its most
sought-after."

-"How could this be?" The dollar-bears wondered."How
could the dollar NOT go down," they asked themselves over
and over...and then it happened. The greenback tumbled
nearly 18% against the euro last year and nearly 25%
against the ancient money known as gold. And now, in the
early days of 2003, the currency James Grant calls the
"Coca-cola of monetary brands" is still rapidly losing its
fizz.

- Accelerating the dollar's decline is a Federal Reserve
that is all-too-eager to"stimulate" the economy by
debasing the currency."In so many words, the Federal
Reserve pledges not to settle for no inflation," writes
Grant."It will try and try until it achieves the desired
level of debasement." To the extent the Fed's mission
"succeeds," the dollar's value will erode.

- During the late 1990s, foreign capital rushed into U.S.
capital markets like married men into a strip club. The
titillating promise of enormous profits insured a steady
flow of foreign capital, which supported the dollar's
value."Even when boom turned to bust," the Economist
notes,"America still looked to be a better home for
capital than many other, even more lackluster economies."

- But times have changed. The returns in the U.S. financial
markets aren't what they used to be. What's more, the
stewards of the dollar's value are not only failing to
prevent the barbarian"inflation" from storming the gates,
but are inviting the barbarian into the castle for
afternoon tea.

-"Some of the dollar's weakness is also likely to be self-
fulfilling," the Economist winds up."As investors become
convinced that the American currency will depreciate, they
will seek an alternative home for their funds. That will,
in turn, put further downward pressure on the dollar."

- Happily, one may still exchange 352 slips of green paper
for one ounce of gold...

-"What were bond buyers smoking?" wonders Andrew Kashdan
of Apogee Research."After President Bush announced his
$670 billion 'growth and jobs' package last Tuesday, the
bond market rallied sharply."

- The bond-buyer"buzz" didn't last long, however, as the
10-year Treasury note tumbled later in the week, driving
its yield up to 4.15% from 4.02% the week before."Our
prediction: more bond market sell-offs ahead," says
Kashdan."Bush's plan may or may not deliver growth and
jobs, but thanks to a renewed burst of government spending,
it is certain to deliver larger deficits. And deficit
spending, all else being equal, is certain to boost
interest rates for all borrowers. Government deficits tend
to 'crowd out' private borrowing.

-"The Congressional Budget Office has estimated that the
government's shortfall this year will be $145 billion, not
including the latest stimulus plans or a possible war,"
Kashdan notes."But mightn't the war on terrorism, a
possible war in Iraq, homeland security and the various
ideas for 'stimulus' make this estimate too optimistic?
We'd be willing to bet on it...Let's see, the Fed is
willing to inflate at all costs...[and] deficit spending
has returned with a vengeance. Taken together, rising
interest rates would seem to be the high-probability
outcome." [For more of Kashdan's insight, see: Apogee
Research. Http://www.agora-inc.com/reports/APG/GainHere/]

- Your co-editor does not disagree.

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Back in Paris...

***"Has the mutual fund industry betrayed investors?" asks
a FORTUNE headline.

Back in the '50s and '60s, John Bogle led the effort to
collectivize America's lumpeninvestoriat. He formed the
Vanguard group - now the 2nd largest in the country - and
pioneered index funds. No need for stock research...no need
to have a stockbroker...no need to know anything about
stocks or how they work - just get in an index fund!

The little guys loved it. Bogle thought he was doing
investors a favor by inviting them onto Wall Street. Now,
come to find out - the mutual fund industry he helped
create is taking advantage of them.

What business did Bogle think Wall Street was in, you might
wonder? Making money for investors...or making money for
itself?

Mutual funds did to their naïve clients just what you'd
expect - they churned 'em and burned 'em. Turnover in
equity portfolios rose from about 15% in the 50% to over
100% today. Costs averaged about 0.75% of assets in the
'50s; they're more than twice as much today.

Meanwhile, portfolio managers became celebrities; the
little investors thought investing was like voting or
choosing a favorite rock & roll band; they chased after the
stars as if they were the Grateful Dead.

"Not stars, but comets," Bogle noticed. No sooner had one
become a household word then he would flare out. Top funds
one year ended at the bottom the next. Following behind in
their day-glo Volkswagens and Jerry Garcia tie-dyed tee-
shirts, the lumpeninvestoriat was always a little late to
the party. By the time they got there, the beer was all
gone!

During the period '84-2001, according to figures from
Dalbar, an investment research firm, the S&P 500 gained
14.5% per year - making it the biggest bull market in
history. But the average equity fund investor made just
4.2% per year. And if you carried the calculations through
to the end of 2002, the rate of return probably falls below
3% - or less than the inflation rate during that period.

Remarkably, the little guys still believe.

*** Today is Maria's birthday. At the beginning of her 17th
year, she's getting some serious modeling work. Yesterday,
she did some work for a fashion supplement to TIME. Next
week, she'll fly down to Mauritius to pose for a French
women's magazine, Madame Figaro. And then...to New York for
the fashion shows in February. What a life!

"Maria, aren't you afraid you're falling behind on your
schoolwork?" her father asked.

"Look, Dad...I can learn history any time...but I can only
do this modeling now..."

And she is right. There is a time for every
temptation...more below...

The Daily Reckoning PRESENTS: When the madness of crowds
begins to take its toll...and American consumer capitalism
begins to crumble...remember to do what you 'ought'.


HOW TO RELAX AND ENJOY THE END OF THE WORLD
by Bill Bonner

The world as we have known it is coming to an end, but what
do we care? We laugh and vow to enjoy it.

It took the Roman Empire hundreds of years to fall. During
that time, most people didn't even know their world was
coming to an end. Most must have gone about their business,
planting their crops, drinking their wine and bouncing
children on their knees, as if the empire were eternal.

Of course, the mobs in Rome itself may have reeled and
wailed with every news flash...

...the barbarians had crossed the Poe...and were headed
South...soon, they would be at the gates!

But others lived quiet lives of desperation and amusement
as if nothing had happened. And what could they have done
about it anyway...except get out of harm's way and tend to
their own affairs?

Plenty of people enjoyed the Great Depression. If you had a
well-paying job, it must have been paradise - no waiting in
lines, no need for a reservation at good restaurants.
Keeping up with the Joneses had never been easier - because
the Joneses were in reverse! If much of the satisfaction of
life comes from feeling superior to other people...what
better time than a depression to enjoy it?

Besides, here at the Daily Reckoning, dear reader, we're
suspicious of headline events. We could never quite get
into the spirit of the Great Boom of the '90s...we doubt
we'll get much juice from the Great Bust either. Nor can we
get very enthusiastic about going to war against enemies we
don't know for reasons we can't understand.

It is a character defect; we just can't seem to get in tune
with mass sentiments. We've never been able to do 'The
Wave' at baseball games without feeling like a fool. Now,
we can't even watch football on television without falling
asleep.

But that is the way of the world; one madness leads to the
next. A man feels excited and expansive because the economy
is said to be in the midst of a New Era...and then he feels
a little exhausted when he discovers that the New Era has
been followed by a New Depression. And all the while, his
life goes on - exactly as it had before. His liquor is no
better, his wife no prettier or uglier, his work every bit
as insipid or inspiring as it was before.

And we have no complaint about it!

Still,"the world is too much with us," wrote Emerson:

"Most men have bound their eyes with one or another
handkerchief, and attached themselves to some one of these
communities of opinion. This conformity makes them not
false in a few particulars, authors of a few lies, but
false in all particulars. Their every truth is not quite
true. Their two is not the real two, their four not the
real four; so that every word they say chagrins us, and we
know not where to begin to set them right. Meantime nature
is not slow to equip us in the prison-uniform of the party
to which we adhere. We come to wear one cut of face and
figure, and acquire by degrees the gentlest asinine
expression..."

What better time to shut the world out and wipe that silly
grin off our face than now - when the world we have known
for 5 decades is coming to an end?

American consumer capitalism is doomed, we think. The
trends that couldn't last forever seem to be coming to an
end...or they will soon. Consumers can't continue to go
deeper into debt. Consumption can't continue to take up
more and more of the GDP. Capital investment and profits
can't go down much further. Foreigners will not continue to
finance Americans' excess consumption until the Second
Coming - at least not at the current dollar price. And
fiat, paper money will not continue to outperform the real
thing - gold - forever.

America will have to find a new economic model; for it can
no longer hope to spend and borrow its way to prosperity.
This is not a cyclical change...but a structural one, which
will take a long time. Partly because structural reforms -
that is, changing the way an economy functions - do not
happen overnight. And partly because the machinery of
collectivized capitalism resists change of any sort. The
Fed tries to buoy the old model with cheaper and cheaper
money. The government comes forward with multi-billion
dollar spending programs to try to simulate real demand.
And the poor lumpeninvestoriat - bless their greedy little
hearts - will never give up the dream of American consumer
capitalism; it will have to be crushed out of them.

The world is so much with these people. TVs are turned on
24-7. Thinking en masse, the latest news gets homogenized
into one gloppy paste, where America's success as an
economy is amalgamated with its success in the war against
terror."Considering that we're going to get an uptick in
corporate profits and a quick win over Iraq," said Scott
Black in one of Barron's Roundtables,"I think the market
will be up 5% to 10% for the year."

Meanwhile, America has become such an outsized military
power that the world has become 'unipolar,' say the latest
editorials. 'Tis a strange world with a single pole, we
note; out of balance, it cannot last.

Nature abhors a monopoly. Thus must America find a way to
destroy itself...and seems to have found two:

First, its consumer economy depends entirely upon the
kindness of overseas strangers. When they are finally fed
up, Americans will have to stop buying...and start saving
themselves. Since it is something that must happen, we will
be happy to see it happen, for we might as well rail
against death as oppose an inevitable change in the
economy."It will all have to be adjusted someday," as Paul
Volcker put it. Why not enjoy it?

Secondly, George W. Bush turned the gods of war against
America when he announced that the U.S. would initiate
armed conflict - with any nation it feels poses a threat.
He has only to pursue this strategy, and he will eventually
turn the whole world against America, too. We don't know
where this leads, but we will try to make the most of it.

Here at the Daily Reckoning, we have already made our New
Year's resolutions. We will try to remember birthdays and
vintages...we resolve to find a better way of curing
ham...and, oh yes, we will buy gold on dips and sell the
dollar and stocks on rallies. The Trade of the Decade, we
keep saying, is to sell stocks and buy gold. This trade has
been good to us so far. At its peak in March 2000, it took
41 ounces of gold to buy the Dow. You can buy it now for
about 25 ounces. Before the decade is over, and here we
take a wild guess, it will be one-to-one, as it was before
the Great Boom began.

This may or may not be a profitable strategy, but we don't
care. We will do what we ought to do, even if it turns out
to be unprofitable. Occasionally we will do what we ought
not, too, but that will be just for fun.


Bill Bonner